Journal of Risk

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Risk sharing and individual life-cycle investing in funded collective pensions

Roderick D. J. Molenaar and Eduard H. M. Ponds

ABSTRACT

This paper deals with the question of whether it is possible to combine the insights and recommendations of optimal individual life-cycle investing with the proven gains of defined benefit pension funds. These gains stem primarily from cost efficiency and (intergenerational) risk sharing. We investigate this subject for a concrete case: the pension fund sector in the Netherlands. Dutch pension funds are traditionally strong in terms of organizing intergenerational risk sharing. There is strong nationwide support among participants, employers and labor unions for continuing with these collaborative funds. However, stakeholders agree that continuous renewal is needed to adapt the system to an ever-changing environment. This paper explores two variants of the current setup. Both variants aim to combine collective risk sharing with the recommendations of individual life-cycle investing. One route is by adding return-related indexation policy to the current widespread practice of wage-related indexation policy. The second route is that participants have age-dependent stakes in an individual plan without risk sharing and a defined benefit plan with risk sharing.

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